The Tax Court held that for purposes
of calculating the qualified residence
interest limitations under Sec. 163(h)(3),
the limitations apply on a per residence,
not a per taxpayer, basis.

Until it issues up-to-date regulations
under Sec. 163, the IRS announced that
taxpayers may use any reasonable method to
allocate excess mortgage debt.

The Seventh Circuit disallowed a
couple’s charitable contribution for
donating their house to a fire department
because the fair market value of the house
did not exceed the value of the benefits
they received in having the house
demolished.

A
taxpayer whose bar was condemned while he
was in prison was permitted to establish
the basis of the building using his
testimony and the testimony of bar
employees and neighbors.

Sec. 32:
Earned Income

In Santana,1 the Tax Court once again
addressed the thorny issue of the child exemption
for divorced parents. The child resided with Mr.
Santana’s ex-wife, but he had a mediation agreement
stating that they would claim the exemption in
alternate years provided he remained current on his
child support payments. The agreement did not
specify which parent would go first, but Mr.
Santana’s ex-wife took the exemption in odd-numbered
years, and in 2008, while current with his child
support payments, he claimed the exemption. He and
his new wife had net earnings from self-employment
of $17,433 and adjusted gross income of $18,949.
Claiming the child as a dependent made them eligible
for the earned income tax credit (EITC).

Unfortunately for Mr. Santana, he did not obtain
or attach to his return a signed Form 8332, Release of Claim to
Exemption for Child of Divorced or Separated
Parents, or an equivalent. The court
explained that, even if Mr. Santana had attached the
mediation agreement, it would not have been an
equivalent because it was unclear on precisely which
years he was entitled to take the exemption and did
not indicate which parent would go first in the
alternating sequence.

The court stated
that,

We are not unsympathetic to petitioners’
position. We also realize that the statutory
requirements may seem to work harsh results to
taxpayers, such as Mr. Santana, who are current in
their child support obligations and who are
entitled to claim the dependency exemption
deductions under the terms of a child support
order. However, we are bound by the statute as it
is written and the accompanying regulations when
consistent therewith.2

Sec. 61: Gross Income Defined

In Walker,3the Tax Court found that allocation of
99% of the income from a dental practice to a
family-owned LLC was an improper assignment of
income. The court found that the LLC’s only purpose
was to avoid income and employment tax and that it
lacked economic substance. The substantial
understatement of tax penalty was upheld against the
dentist (the father of other LLC members).

Sec. 103: Interest on State and Local Bonds

In DeNaples,4 the taxpayer’s land was
condemned by the state. The parties reached an
agreement for the state to pay the landowner with a
five-year note. The taxpayer excluded the interest
income from the note from his income per Sec. 103.
The IRS disagreed, finding that Sec. 103 did not
apply to the note, and the Tax Court agreed with the
IRS.

The Third Circuit, however, found that
Sec. 103 applied and reversed the Tax Court, stating
that,

The court also noted that “the purpose underlying
Section 103 was well served in this case.”

Sec. 104: Compensation for Injuries or
Sickness

In Sewards,6 the taxpayer, a sheriff, retired after he
became disabled. He received payments under a plan
that was called a service-connected disability
retirement and did not report these payments on
his tax return, claiming they were nontaxable
disability payments. The court, however, held
that, to the extent the payments were increased
based on the taxpayer’s length of service, they
could not be excluded under Sec. 104:
“Section 104(a)(1) does not apply, however,
to the extent the payments are determined by
reference to the employee’s age or length of service
or the employee’s prior contributions, even if the
employee’s retirement is occasioned by occupational
injury. Sec. 1.104-1(b), Income Tax Regs.”7

Sec. 107: Rental
Value of Parsonages

In Driscoll,8 the court overturned a
Tax Court decision and held that the exclusion for
parsonage allowances under Sec. 107 applied to only
one home rather than two. More specifically, the
court found that under the rules of statutory
construction “home” meant a single home, and that
this interpretation was supported by the legislative
history dating back to 1921. The court also noted
that income exclusions should be “narrowly
construed.”

Sec. 108: Income From Discharge of
Indebtedness

In Brooks,9 the court addressed the
issue of forgiven interest on an employment-related
loan. Mr. Brooks, a stockbroker, received a loan of
more than $500,000 from his employer (Dain) in March
1998 with the proviso that if he remained employed
for five years, both the principal and the accrued
interest would be forgiven. In 2003, Dain reported
the amount of the forgiven principal and interest
(approximately $650,000) as income to Brooks on his
Form W-2, Wage and
Tax Statement. Brooks reported the full
amount on his return and paid the income tax on
it.

The IRS issued a notice of deficiency to
Brooks about other matters on his 2003 return, which
the parties settled, but Brooks now claimed that the
interest should be excluded under Sec. 108(e)(2),
which excludes from cancellation of debt income any
amount that would have given rise to a deduction. He
argued that the interest would have been deductible
under Sec. 212 as an expense for the production of
income, namely for stock purchases to prove his
ability as a stockbroker to Dain. The IRS argued,
and the court agreed, that the taxpayer did not
attempt to trace the flow of funds received from
Dain to prove their usage. The court further noted
that, even if the interest could be traced to the
stock purchases, its deductibilty would be limited
as investment interest expense under Sec. 163(d).
The court denied Brooks’s claim of income exclusion
for the forgiven interest.

In T.D. 9557, the
IRS added Regs. Sec. 1.108-8, addressing the
transfer of a partnership interest to satisfy a
debt. The regulations provide instructions and an
example to calculate the amount of debt forgiven
when a partnership exchanges an equity interest for
outstanding debt.

Sec. 131: Certain Foster
Care Payments

In Stromme,10 the taxpayers excluded
from income approximately $550,000 in foster care
payments from the state of Minnesota during tax
years 2005 and 2006. The IRS decided that the
payments were not excludable under Sec. 131 and,
after allowing some business expense deductions,
issued a deficiency for more than $140,000.

The Strommes owned two homes, one that appeared
to be their primary residence and a second that was
used to house individuals with developmental
disabilities. Although they maintained an office at
this second property, spent significant time there,
and occasionally slept over, the court determined
that they were unable to exclude the payments from
gross income because they did not live in that
house. However, the court disagreed with the IRS’s
imposition of an accuracy-related penalty: “[G]iven
the ambiguity in this area of law, we find the
Strommes’ confusion reasonable and honest.”

Sec. 162: Trade or Business
Expenses

In Porch,11 an IRS audit revealed
that the taxpayers understated Schedule C income by
roughly $50,000 a year in 2005 and 2006. They also
failed to report a small capital gain and took a
number of unsubstantiated business expenses. It was
not an unusual case except that their defense was
that they used a tax return preparer who did not
sign the returns. They further argued that the
return preparer was elderly and failed to include
the additional income on their returns. Not only did
the court uphold the IRS deficiency determinations,
but it also upheld the IRS’s imposition of the fraud
penalty under Sec. 6663.

Failing to file for
six years, fictitious net operating losses (NOLs),
unreported rental income—none of these make Esrig12 worth noting. Two
elements separate this case from the run of the
mill, though. First, one of the taxpayers claimed
home office expenses for a large fish tank in the
foyer of their home where business contacts would
sit and wait for meetings. The second was their
claim that their returns were not filed because
their accountant had been sent to prison for
murdering her husband and that her staff had made
many mistakes. The taxpayers presented “no evidence
to support this lurid tale,” so the court rejected
it as a reasonable cause defense to penalties.

The court agreed with IRS determinations of
income, deductions, and gain on returns for the
years 1998 through 2000 that were filed so late that
the IRS prepared substitute returns. On the
taxpayers’ returns, they claimed NOLs, underreported
their rental income, and overreported the basis of
assets sold. They did not substantiate any of their
expenses for their real estate rental and repair
business and failed to provide credible testimony at
the trial.

In Hand,13 a real estate broker
tried to claim flight training was a necessary
expense for his business. The court found that he
failed to produce any evidence of a direct or
proximate relationship between the flying lessons
and the skills he required as a commercial
realtor.

Cibotti,14 a relatively typical
case primarily involving substantiation requirements
for certain business expenses, had an interesting
sideline issue. A mortgage loan officer claimed that
even though he received a Form W-2 from a business
in which he was a minority shareholder, he was
actually an independent contractor and was entitled
to deduct his expenses on Schedule C and was not
subject to the 2% floor on miscellaneous itemized
deductions on Schedule A. Somewhat surprisingly, the
Tax Court agreed after reviewing the usual set of
factors. The court’s analysis is interesting because
this case involves the opposite of the usual
employee vs. independent contractor
disagreement.

Mobasher15 might belong under
Sec. 183, but the activity really cannot be called a
hobby. The taxpayer worked full time in a sign
manufacturing business that he had started, but he
also claimed to be a real estate agent (an activity
his brother engaged in and had convinced him to
try). While he did get a license and training from
RE/MAX, he reported no income from his real estate
activities and claimed expenses averaging almost
$10,000 a year on Schedules C for tax years 2004,
2006, and 2007. Because there was no evidence that
his real estate activity was a trade or business
activity, the Schedule C expenses were
disallowed.

Sec. 163: Interest

In
Sophy,16 the Tax Court declared
that for purposes of calculating the qualified
residence interest limitations under Sec. 163(h)(3),
the limitations apply on a per-residence basis, even
if two co-owners are unrelated parties. See Tax
Trends, “Qualified
Residence Interest Limits Apply on a Per Residence
Basis,” 43 The
Tax Adviser 354 (May 2012), for a detailed
discussion of this case.

In Chief Counsel
Advice (CCA) 201201017,17 the IRS discussed
allocation of excess mortgage debt under Temp. Regs.
Sec. 1.163-10T, which was issued in 1987. Until the
IRS issues updated regulations, taxpayers may use
any
reasonable method of allocating excess mortgage
debt, including the exact and simplified methods
outlined in the temporary regulations. Furthermore,
if the taxpayer is using the simplified method, he
or she is permitted to allocate excess interest
under the interest tracing rules of Temp. Regs. Sec.
1.163-8T without making the election in Temp. Regs.
Sec. 1.163-10T(o)(5) to treat the debt as not
secured by a qualified residence. The election under
Temp. Regs. Sec. 1.163-10T(o)(5) applies to the
entire debt.

Sec. 164: Taxes

The IRS
issued an Information Letter18 clarifying that real
property taxes “may, depending on the facts and
circumstances, be deductible as real property taxes
even though they are not imposed on an ad valorem
basis.” As a result, California, which conforms to
federal law on the deductibility of real property
taxes, explained that its earlier position was wrong
and that it would revise California’s forms and
instructions once the IRS did.19

Sec. 170:
Charitable Contributions and Gifts

The
Seventh Circuit upheld the Tax Court’s decision in
Rolfs20 that a couple’s
donation of their home to a local fire department
for demolition had zero value and thus they could
not claim a charitable contribution. The court’s
decision effectively ends the precedent set in Scharf21 by establishing that a
donor is only entitled to a charitable contribution
to the extent the fair market value (FMV) of
contributed property exceeds the FMV of the benefits
received by the donor (in this case, the cost of
demolishing their home to allow construction of a
new one).

Underscoring the increasing number
of Tax Court cases involving donations of
conservation easements under Sec. 170(h)(4)(A), the
IRS in late November 2011 issued an Audit Techniques
Guide (ATG) devoted to the issue.22 ATGs serve as a road
map for practitioners and IRS examiners of the
proper procedures to follow when considering a
particular transaction that frequently draws IRS
scrutiny.

Colorado was the location for
conservation easements of land parcels in two cases
in which the IRS prevailed. In Esgar,23 three taxpayers
claimed charitable contributions of more than $2.27
million combined, claiming that the best predonation
use of the land was as a gravel mine. The Tax Court
agreed with the IRS that its best use was actually
agricultural and reduced the value of the donations
to under $100,000. In Carpenter,24 the court found that
the taxpayers did not satisfy the requirement that
the easement be granted in perpetuity. The deeds
contained a provision that if the “circumstances
arise . . . that render the purpose of this
Conservation Easement impossible to accomplish,” the
easement would be terminated. The court wrote, “We
do not find that petitioners intended to donate
their property . . . with a general charitable
purpose.”

In another conservation easement
case,25 this one on Martha’s
Vineyard, the Tax Court upheld the IRS’s
disallowance of a $4.5 million charitable
contribution because of deficiencies in the
acknowledgment letter from the recipient, the Nature
Conservancy. Unlike a slew of previous cases where a
gift letter was not provided or provided late, in
this case the Nature Conservancy left out some of
the consideration it provided the donors. The court
believed that this precluded a finding of a
good-faith effort to comply with the requirements of
Sec. 170(f)(8).

As of the end of April 2012,
there were 216 docketed cases in the Tax Court
involving this issue.

Sec. 183: Activities
Not Engaged in For Profit

In Strode,26 the taxpayer was a
successful attorney, earning around $175,000 a year.
He also claimed business deductions on a Schedule C
for an “international consulting” business of around
$80,000 a year with no income reported for the
business. This pattern existed for tax years 2003
through 2008. For some undisclosed reason, either
the IRS assessed deficiencies (or the taxpayer
challenged them) only for tax years 2005 and 2007.
The taxpayer failed to testify at trial or make much
of a case, claiming he “could not spare the time.”
To no one’s surprise, he lost the case, and the
court also upheld a 20% accuracy-related
penalty.

In Bronson,27 the IRS won a
horse-breeding case. Over 11 years, the taxpayers
had gross receipts from horse breeding of just
$25,000 while racking up losses of more than
$837,000. Meanwhile, the husband was a successful
attorney with an average net income of more than
$200,000 a year. This case provides a near-perfect
guide to what not to do if you
want to claim horse breeding as a trade or
business.

Sec. 213: Medical, Dental
Expenses

In Gaerttner,28 the taxpayers jointly
filed their 2005 income tax return, claiming a
medical and dental expense deduction of $20,915.
They contended they were entitled to the full
deduction of their medical and dental expenses,
including expenses from a 2002 automobile accident,
dental expenses, and prescription drug co-payments.
The Tax Court determined that the taxpayers were not
entitled to the deduction for medical expenses from
the accident because an insurance settlement was
received. Additionally, the taxpayers were not
entitled to deductions for expenses that they failed
to substantiate. To substantiate the expenses, the
taxpayers had submitted photocopied adding machine
tapes, which were unreadable and contained
handwritten notations.

Sec. 215: Alimony
Payments

In LaPoint,29 the taxpayer, a
professional baseball player, entered into a
postnuptial agreement. The agreement assigned to his
spouse his interest in any funds he received from
the resolution of an arbitration between the Major
League Baseball Players Association and the owners
of 26 MLB clubs. Additionally, he agreed to deposit
$50,000 annually into a bank account for his spouse,
so long as he received compensation from playing
baseball, and he agreed to maintain health insurance
for his spouse and any children born to them.

In the event of divorce, his spouse was entitled
to retain ownership of the MLB proceeds and the
$50,000 annual payments. Also included in the
postnuptial agreement was a provision indicating
that it was “binding on heirs”—meaning, it would
inure to the benefit of, and be binding upon, the
parties, their heirs, executors, legal
representatives, and assigns.

The couple
divorced in 2005. Because the obligation to make the
payments to the taxpayer’s spouse would have
survived her death, the payments were not considered
alimony for federal income tax purposes per Secs.
71(b) and 215(b) and therefore were not
deductible.

Sec. 217: Moving Expenses

In Olagunju,30 a husband and wife
were denied a deduction they claimed for moving
expenses because they were not job-related. On their
jointly filed 2008 income tax return, the taxpayers
deducted $8,600 of moving expenses, yet they did not
explain why they were entitled to the deduction.
They introduced into evidence a freight bill from a
moving company, an estimate from a moving company,
and a $49 vendor receipt.

Sec. 217(a)
provides that “there shall be allowed as a deduction
moving expenses paid or incurred during the taxable
year in connection with the commencement of work by
the taxpayer as an employee or as a self-employed
individual at a new principal place of work.”
Because the taxpayers failed to offer sufficient and
credible evidence that their move was job related,
the deduction was denied.

Sec. 263: Capital
Expenditures

Bailey,31 a complicated,
143-page Tax Court opinion with a table of contents
and proposed deficiency exceeding $4 million over
nine years, involved F. Lee Bailey. Bailey was the
sole owner of an S corporation called Palm Beach
Roamer (PBR), through which Bailey intended to
remanufacture small planes and sell them for less
than new airplanes. He called these remanufacturing
efforts “Project 288,” which the IRS and Tax Court
determined he engaged in for profit from 1994 to
1996, despite its failure to generate a profit.

PRB created only a prototype and did not develop
manufacturing processes. Thus, the IRS claimed that
expenses for the project were not currently
deductible, but were instead either startup expenses
or capital expenditures under Sec. 263(a)(1). If the
expenditures were intended to build a specified
asset, such as the prototype plane, those
expenditures would be considered part of the basis
for that specific asset. The court ruled that
because there was insufficient evidence to support
that the expenses Bailey claimed were for a purpose
other than the development of a prototype, these
were capital expenditures and part of basis. Some of
the expenditures were deductible in the year the
project was terminated.

Sec. 280A:
Disallowance of Certain Expenses in Connection With
Business Use of Home, Rental of Vacation Homes

In Ong,32 the Tax Court denied
the taxpayer a deduction for various expenses of two
houses that she claimed she used for business: One
was her principal residence, and the other was her
son’s principal residence. The court denied the
deductions for the house the taxpayer lived in
because the taxpayer made personal use of the house
and failed to prove that any part of the house was
used exclusively for business. With regard to the
house her son lived in, the court noted that if a
family member of a taxpayer lives in a house, that
family member’s personal use of the house would be
attributable to the taxpayer. Thus, because she was
deemed to have made personal use of the house and
failed to establish that she had used any part of
the house exclusively for business, the Tax Court
denied the deductions for the house.

Sec.
469: Passive Activity Losses and Credits
Limited

In Iversen,33 the taxpayers argued
that they were entitled to deduct losses from a
cattle ranching activity because they materially
participated in the activity. They claimed they
spent more than 500 hours working on the ranch and
the husband served as the day-to-day manager. The
taxpayers did not offer evidence to support those
claims, and the facts indicated otherwise. The
husband worked as president and founder of a medical
equipment manufacturing company, the taxpayers lived
in another state, and the ranch had a full-time
manager.

The court held for the IRS, finding
that the taxpayer’s work for the ranch fell more
into the investor category and, as such, did not
count toward satisfying the more than 500 hours of
material participation test.34 The court did not
uphold the accuracy-related penalty, however,
finding that the taxpayers reasonably relied on
their CPA’s advice. The “accountant should have
known better, particularly if the accountant was
shown no more evidence and documentation than was
shown to us.”

In Langille,35 the taxpayer
maintained a law practice as well as real estate
rentals, which she argued were “one single activity”
for purposes of Sec. 469. She also argued that she
was entitled to the special rule for real estate
professionals under Sec. 469(c)(7), but the Eleventh
Circuit agreed with the Tax Court’s holding that the
taxpayer did not spend over half of her time or more
than 750 hours “in real property trades or
businesses.” The court also found that the
taxpayer’s real estate and law practice activities
did not qualify as a single activity.

In
Vandegrift,36 the taxpayers owned
nine real estate properties. The husband worked as a
salesman for an unrelated company, earning a salary
of $120,000. Although the taxpayers argued that the
husband qualified as a real estate professional, the
Tax Court concluded that the husband’s estimate of
the time he spent in those activities was suspect
because of his full-time job and the lack of
contemporaneous time records. The court held that
lack of records meant that the burden of proof did
not shift to the IRS and the taxpayers’ losses were
disallowed. The taxpayers did prevail on their other
claim, that all of their real estate activities were
one activity for which the gains and losses had to
be netted.

In Iovine,37 the taxpayers worked
for American Airlines as a pilot and flight
attendant. The husband had an Illinois real estate
brokers’ license, and he and his wife owned a number
of properties, which they rented. They deducted the
losses on their return, taking the position that
these rental real estate losses were nonpassive
because the husband qualified as a real estate
professional.

The IRS and Tax Court found that
he did not qualify in 2005 since he did not prove he
met the time requirements because his time logs were
not contemporaneously kept and were at best a
“ballpark guesstimate.” For 2006, the court agreed
that the husband spent more than half of his time in
the real property trades or businesses, but he did
not meet the material participation test for all of
the properties, which meant that the time spent on
those rentals had to be subtracted from his total
hours. With that reduction, he did not work the
required number of hours to be a real estate
professional under Sec. 469(c)(7). In addition, the
taxpayers could not treat the rentals as a single
activity for measuring material participation
because they had not elected to do so.

In
Samarasinghe,38 the taxpayers owned a
commercial office building that they rented to the
husband’s wholly owned medical corporation starting
in 1980. The taxpayers reported the rental income as
passive and offset passive losses from other
activities against it, but the IRS assessed a
deficiency against the taxpayers with respect to the
rental income for the years 2005 through 2007,
claiming that the rental income from the commercial
building was self-rental income under Regs. Sec.
1.469-2(f)(6), which required it to be
recharacterized as nonpassive income.

The
taxpayers argued that the self-rental rule did not
apply because they were entitled to transitional
relief under Regs. Sec. 1.469-11(c)(1)(ii) for
rental income “pursuant to a written binding
contract entered into before February 19, 1988.” To
qualify for this relief, a taxpayer must prove that
the rental income was paid under a written lease
entered into before Feb. 19, 1988, that was still in
effect. The court concluded that in 2005 through
2007, the taxpayers and the medical corporation did
not pay much attention to the terms of the 1980
lease. The court described the lease as “a
meaningless document that was simply not followed”
in those years by the parties. Therefore the
taxpayers were subject to the self-rental income
recharacterization rule.

Three cases39 involved similar fact
patterns where taxpayers participated in
micro-utility activities, claiming losses and Sec.
48 business energy investment credits on their
returns. The IRS disallowed the losses because they
arose either from an activity in which the taxpayers
did not materially participate or from a rental
activity, which is automatically a passive activity.
The taxpayers countered that their micro-utility
businesses were not a passive rental activity and
that they materially participated. While the
taxpayers were the sole owners of the micro-utility
activity, they had contracted with a company to
handle most day-to-day administrative work, such as
collecting payments and sending invoices. The Tax
Court found that the contractor’s work caused the
taxpayers to not meet any material participation
test. Thus, the losses were passive activity
losses.

Sec. 1011: Adjusted Basis for
Determining Gain or Loss

Wilson40 is a colorful case of
reconstruction of events to determine the basis of a
commercial property. The case provides a road map
for reconstruction of basis based on corroborated
testimony. In 2000, while a bar owner was serving a
prison sentence, his bar property was condemned and
acquired by the city of Des Moines, Iowa, for
airport expansion. The owner had made significant
improvements to the bar property over the years,
including installing a parking lot, replacing the
bar building’s roof after it collapsed, and later
rebuilding the bar building after a major fire. The
taxpayer’s testimony and that of bar employees and
neighbors, along with tax appraisals, convinced the
court of the amounts spent for improvements that
could be included in basis.

Sec. 1031:
Exchange of Property Held for Productive Use or
Investment

Replacement property in a like-kind
exchange ultimately became the taxpayers’ personal
residence, but the Tax Court found it qualified as
replacement property under Sec. 1031 because the
owners proved investment intent at the time of the
exchange.41 When the owners
applied for a real estate loan to purchase the
replacement property, they indicated it was for
investment and tried unsuccessfully to rent the
property for several months after purchasing it.
After property values fell significantly in the area
(Lake Tahoe), they decided it was financially more
beneficial to sell their primary residence and move
to the replacement property. However, based on the
testimony at the trial, the court found that at the
time of the exchange, the taxpayers intended to hold
the replacement property as an investment and not to
use it as a residence.

Sec. 1045: Rollover
of Gain From Qualified Small Business Stock to
Another Qualified Small Business Stock

In a
Tax Court case, the court held that the taxpayers’
investment of qualified small business stock sale
proceeds into a jewelry and gem business did not
qualify under Sec. 1045 because the new business did
not meet the active business test, which requires
that at least 80% of the assets of the new
corporation be used in an active trade or
business.42 Of the more than $1.9
million invested, only $147,000 of inventory was
purchased, and all but 8% of the sales proceeds were
held in cash.

Sec. 1234: Options to Buy or
Sell

Settlement of put contracts with borrowed
shares closes the transactions for tax purposes, the
IRS ruled in a technical advice memorandum.43 The fact that the
borrowed shares’ ultimate value is indeterminable at
the time of a put contract settlement does not
support open transaction treatment.

Sec.
1256: Contracts Marked to Market

In Wright,44 the taxpayers, through
their wholly owned LLC, deducted losses on foreign
currency options when the options were assigned to
another entity, taking the position that the
assignment resulted in a termination of a contract.
The market value of the options at the time of
transfer was less than the basis. The Tax Court
determined that the rules of Sec. 1256 do not apply
to foreign currency options because foreign currency
options are not foreign currency contracts as
defined in Sec. 1256(g)(2). Options may never be
exercised, whereas contracts require actual delivery
of the currency under contract.

Sec. 6015:
Relief From Joint and Several Liability on Joint
Return

In Melot,45 the taxpayer attempted
to claim innocent spouse relief in a collection
case, in which the basis of the tax liability came
from returns the IRS prepared. Since Ms. Melot did
not file a joint return with her husband, a district
court held that she was ineligible for relief under
Sec. 6015.

In Miles,46 the taxpayer attempted
to claim innocent spouse relief for the first time
in her court filings. The U.S. District Court
properly stated that a taxpayer claiming innocent
spouse relief must first exhaust all remedies with
the IRS. Ms. Miles never filed a Form 8857, Request for Innocent
Spouse Relief, and thus the district court
was unable to consider her claim.

In Zaher,47 the court dealt with a
particularly unpleasant intervening ex-spouse. Even
the IRS acknowledged at trial that the husband’s
egregious misconduct weighed in favor of relief for
the petitioner. The husband sold his gas station in
2006 and deposited the proceeds into a joint
account. One week before his wife filed for divorce
in 2007, he transferred those funds first to his
separate business account and then to his brother to
distribute to other family members. The couple
failed to file their 2006 return timely and did not
pay the tax due on the return. As an intervening
party in his wife’s case, the husband tried to claim
that his wife should pay the entire outstanding
liability.

Sec. 6654: Failure by Individual to
Pay Estimated Income Tax

Under Sec. 6654(a),
for tax years beginning after Dec. 31, 2012, the
addition to tax now includes tax under Chapter 2A
(the Sec. 1411 3.8% Medicare tax).48

In McLaine,49 the taxpayer and his
former spouse reported a tax liability of $3,276,333
on their 1999 federal tax return, no withholding,
total payments of $1.6 million, and an amount due of
$1,676,333, which was not remitted with the return.
Payments of $1.6 million were made in July and
October of 2001, and a penalty for failure to pay
estimated taxes was assessed in the amount of
$101,872. The former spouse requested and received
joint liability relief.

The taxpayer argued
that the addition to tax assessed under Sec. 6654
“would be against equity and good conscience” within
the meaning of Sec. 6654(e)(3)(A). Sec.
6654(e)(3)(A) states that “No addition to tax shall
be imposed under subsection (a) with respect to any
underpayment to the extent the Secretary determines
that by reason of casualty, disaster, or other
unusual circumstances the imposition of such
addition to tax would be against equity and good
conscience.”

The taxpayer argued undue hardship
on the ground that he lacked the ability to
ascertain his 1999 tax liability despite good-faith
attempts to do so. The taxpayer also argued that he
paid as much of the income tax as possible despite
the financial hardship that the payments caused him.
As his third and final argument, the taxpayer argued
that his alcoholism constituted reasonable cause for
failure to timely file his 1999 tax liability. The
court ruled that the evidence of undue hardship and
alcoholism did not support a finding that the
assessment of the Sec. 6654(a) addition of tax
“would be against equity and good conscience” within
the meaning of Sec. 6654(e)(3)(A).

In Dykema,50 the Eighth Circuit
upheld a ruling of the Tax Court that dismissed a
taxpayer’s petition challenging a notice of
deficiency issued by the IRS, upheld the
assessments, and imposed sanctions against the
taxpayer for asserting frivolous arguments. The
taxpayer received the notice of deficiency for the
2006 through 2008 tax years and argued that his
income from self-employment during those years was
not income because he was not “privileged to receive
‘wages’ or ‘income’ as defined by the Code” because
he was not in public office. Sec. 7701(a) states
that “a trade or business” includes “the performance
of a public office.” The court argued that this
cannot be interpreted to mean that it is limited to
“performance of a public office,” as the taxpayer
argued.

In Trupp,51 the IRS prepared a
substitute for return (SFR) for a taxpayer who
failed to file a tax return for 2005. According to
the SFR, the taxpayer had a tax liability of
$93,841, and he was assessed additions to tax under
Secs. 6651(a) and 6654. The taxpayer, an attorney,
claimed that he was entitled to various deductions
that were not included on the SFR, including
cellphone expenses, client storage expenses, travel
expenses, accounting expenses, and expenses incurred
as part of the taxpayer’s “equine industry law
marketing campaign.”

The taxpayer’s two
arguments were that his equestrian activities and
legal practice were a single activity and that the
equestrian-related expenses were deductible, as the
activity was engaged in for a profit. Under Regs.
Sec. 1.183-1(d)(1), multiple undertakings of a
taxpayer may be treated as one activity if they are
sufficiently interconnected.

The most
important factors in making the determination are
the degree of organizational and economic
interrelationship of the activities, the business
purpose served by carrying on the activities
together, and the similarity of the activities.
After reviewing the evidence submitted, the court
found that the taxpayer’s characterization of his
equestrian activities and his legal practice as one
activity was unreasonable and disallowed the
equestrian-related expenses because the equestrian
activity was not engaged in for profit.

Karl Fava is a
principal with Business Financial
Consultants Inc. in Dearborn, Mich. Edward
Gershman is a partner with Deloitte Tax LLP
in Chicago. Janet Hagy is a shareholder with
Hagy & Associates PC in Austin, Texas.
Jonathan Horn is a sole practitioner
specializing in taxation in New York City.
Daniel Moore is with D.T. Moore & Co.
LLC, in Salem, Ohio. Annette Nellen is a
professor in the Department of Accounting
and Finance at San José State University in
San José, Calif. Dennis Newman is a tax
manager with Sharrard McGee & Co. PA, in
Greensboro, N.C. Teri Newman is a partner
with Blackman Kallick in Chicago. Kenneth
Rubin is a partner with RubinBrown LLP in
St. Louis. Amy Vega is a senior tax manager
with Grant Thornton LLP in New York City.
Prof. Nellen is chair and the other authors
are members of the AICPA Individual Income
Tax Technical Resource Panel. For more
information about this article, contact
Prof. Nellen at annette.nellen@sjsu.edu.

The winners of The Tax Adviser’s 2016 Best Article Award are Edward Schnee, CPA, Ph.D., and W. Eugene Seago, J.D., Ph.D., for their article, “Taxation of Worthless and Abandoned Partnership Interests.”

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